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Friday, October 03, 2008

Oct. 3, 2008: A day that will live in stupidity

The day the bailout plan was passed by the house and signed by that economic genius, George W. Bush, is a day that will live in stupidity.

Congress has let them be hoodwinked again by WMD's -- this time Weapons of Mortgage Destruction -- and agreed to give Paulson $700 billion to do what?

1. Who elected Paulson God? Even in the revised bill, he has unprecedented powers. This is yet one more power grab for the executive branch. I happen to particularly despite the Bush-Cheney version of the executive branch, but really I wouldn't trust myself to have this much power with so few checks and balances.

2. There's no coherent pricing mechanism explained. If we pay market, the taxpayers might break even -- but then the banks will be visibly insolvent. If we may above market, taxpayers will get hosed. It gets explained both ways, but obviously that can't happen.

This is a good rule when dealing with financial institutions: if it's not clear what's happening, you are getting screwed.

The consensus among economists is now clear, the best strategy for dealing with the financial crisis is to recapitalize the banks that need recapitalization. Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan and many others all advocate some form of recapitalization as do Tyler Cowen and myself. Krugman would prefer a recapitalization in the form of nationalization. In my view, there is still plenty of private money to buy banks at the right price and my preferred model is the FDIC leading a speed bankruptcy procedure, as was done brilliantly with Washington Mutual (Cochrane also supports this model.) In the middle are most of the others who have a variety of good ideas to require the banks to raise equity in various ways.

The consensus policy of economists would put most of the burden of adjustment on politically powerful holders of equity and bonds.

There is also a consensus among economists that the bailout bill is not the right policy. None of the above economists, for example, is enthusiastic about the bailout. My bet is that all of us think that the bailout has a substantial likelihood of failing. The support that exists is born out of hope and fear not judgment and experience.